Sunday, 29 April 2007

The dusty collection of small sheds in Kushaiguda, outlying Hyderabad, hardly seems like a sensitive defence establishment, but this will soon be a highly-controlled air-conditioned facility. From September 2007, 65 highly trained workers of private Indian manufacturer HBL-ELTA Avionics will produce, entirely for export to Israeli defence major ELTA, high-tech radar components for which technology has been supplied by ELTA. In a phrase, HBL-ELTA Avionics is an export-oriented defence sector JV.

Talking to HBL’s CMD, Jagdish Prasad, it soon becomes clear that HBL’s approach towards the technology it buys from foreign partners is radically different from that of the MoD’s production units. A defence PSU like Bharat Electronics Limited (BEL), which purchased night vision technology from Dutch major Delft just a decade ago, is already in the process of buying an upgraded version of the same technology, at a price that will exceed Rs 100 crores. In contrast, private sector HBL, having paid once for technology from ELTA, is absorbing that technology, and readying in-house R&D to improve on it. Like the IT industry, HBL plans to move up the value chain --- from technology absorption, to product improvement, to developing its own product that is technologically superior to what the foreign partner is offering.

Jagdish Prasad explains the difference, “Historically, in both IT and the defence field, the smaller companies have driven technology development. There’s a hunger to grow and an appetite for technology.”

This R&D hunger has already caused the MoD to shift policy gears, abandoning its exclusive reliance for R&D on its bloated public sector defence establishment. Instead, the MoD will also tap into the more nimble and tech-savvy private defence companies, subsidising their R&D in MoD-nominated projects to the extent of 80% of R&D costs.

The targets of this R&D opening, private Indian defence companies like HBL, Astra Microwave, Alpha Design Technologies, and Mahindra Defence Systems have learnt to walk without MoD crutches. Largely ignored by the MoD since they were first allowed into defence manufacturing in 2001, most have tied up with foreign defence majors that chose the JV route as a lever to crack the Indian defence market. The 26% cap on foreign equity in defence, and the MoD’s tendency to tilt the playing field in favour of the public sector, has not deterred international majors. The advantages of India’s manpower pool and vastly cheaper R&D, testing, and establishment costs provided sufficient incentives for tie-ups. With offsets having recently been made mandatory for defence deals of over Rs 300 crores, JVs in India also provide foreign majors with a way to “bank” offset credits for future defence contracts.

With JVs already in place and with private sector R&D already functioning because of a research-oriented attitude towards growth, there is only guarded enthusiasm for the MoD’s new policy of funding private R&D. If HBL accepts MoD funding for R&D, says Jagdish Prasad, it could create disputes over Intellectual Property Rights (IPR). Prasad says that “While an R&D subsidy seems attractive, I cannot second-guess what the government will want to do with the IPR. My company will have part-funded the R&D and I will worry about what happens afterwards on my product’s IPR.”

The real advantage of MoD-subsidised R&D, say private defence manufacturers, lies in the fact that the development contract will specify that the MoD will test the equipment or technology that is developed. Top MoD officials accept that the greatest deterrent to private sector R&D expenditure is the fear that the product will never make it into service. One reason for that is that the MoD has neither the obligation, nor the budget, to test every product that private companies develop. It is only the DRDO that is assured of every product being tested by the user. Now, in the case of subsidised R&D, private companies hope anticipate that MoD audit requirements will make it mandatory to test the products that come out.

Friday, 27 April 2007

Indian army soldiers who use outdated night vision devices (NVDs) to maintain a year-round vigil on the Line of Control (LoC) with Pakistan, should be pleased with the MoD’s recent decision to subsidise R&D by selected private defence manufacturers. The Defence PSU, Bharat Electronics Limited (BEL), has proved unable mobilise R&D to upgrade the NVDs it supplies the army. But now, private sector companies that are nominated as Raksha Utpadan Ratnas (RuRs) can draw upon a corpus of Rs 100 crores, from the MoD’s capital budget, to fund specific R&D projects like upgrading NVDs. But the MoD’s unwillingness to empower private companies to supply high-grade NVDs indicates that the new R&D policy still runs up against old practices and habits.

The NVD story is complex, but illustrates the contradictions in the MoD’s procurement, manufacture and R&D policies. It began with the J&K insurgency in the early 1990s, with the army urgently demanding lightweight Night Vision Binoculars (NVBs) and Night Vision Goggles (NVGs) to staunch the flood of militants across the LoC. (NVBs are heavier and more expensive than NVGs because NVBs magnify images.) The army also demanded Passive Night Sights (PNS) that would be fitted onto its INSAS and AK-47 rifles, allowing them to shoot accurately in darkness. With the private sector excluded from defence until 2001, BEL and the Ordnance Factories formed a JV called BELOP, purchased NVD technology from Delft, a Dutch defence major, and churned out thousands of 2nd Generation (Gen-2) NVDs that became quickly outdated.

The defence R&D and production establishment (the DRDO, 40 ordinance factories and 8 Defence PSUs) have always touted transfer of technology (ToT) as the first step to indigenous development. But without any R&D by BELOP to improve their NVDs beyond Delft’s Gen-2 technology, the militants soon had a qualitative edge in NVDs.

But the MoD asked BEL no hard questions about R&D. Instead, encouraged by BEL, the MoD initiated in 2005 a new initiative to procure state-of-the-art NVDs, which had by then improved from Gen-2 to SuperGen and HyperGen. But now private companies were competing with BEL in defence manufacture, offering not just production but R&D and product improvement as well. Intent on shutting out competition, BEL marched into the MoD with a 1996 letter (issued before the private sector was allowed into defence production) that stipulated BEL would produce all NVDs for the military.

The Secretary (Defence Production), Mr KP Singh, told Business Standard that he turned down BEL’s demand. “I told BEL that we have opened defence manufacture to the private sector, so we can no longer pass such an order. If technology has to be passed on to the private sector, then it will be.”

But while turning down BEL’s demand for monopoly over NVD production, the MoD effectively gifted BEL with the NVD contract. Violating its own Defence Procurement Policy of 2006 (DPP-2006), the MoD allowed BEL to preside over the selection procedure. On 12th December 2006, BEL issued a Request for Proposal (RFP) to defence manufacturers worldwide, asking them to submit tenders for 30,634 NVDs. (This document is in my possession). BEL’s miserable record with Gen-2 NVDs, and its inability to improve them with in-house R&D was overlooked. Instead of competing with other companies to supply NVDs for the military, BEL was handed ownership of the NVD project.

Colonel HS Shankar, who was the Chairman of BELOP from 1997-2003, admits that BELOP made no effort was made to improve its NVDs but blames that on BEL’s disinterest in funding R&D. Now heading a private company that is bidding to supply NVDs, he points out that absorbing technology and improving it with in-house R&D would be an important goal of private companies.

But Secretary (Defence Production), KP Singh, points to BEL’s record in giving it preference over its competitors, stating, “BEL already has the technology to manufacture Gen-2 NVDs. So getting them third generation technology is a natural progression. BEL will produce the II tubes after importing the technology.”

On 22nd January 2007, at a meeting in BEL, private vendors bidding to supply NVDs to the army vehemently protested BEL being given the project. (The minutes of that meeting, issued by BEL, are in my possession). This month, a CII delegation raised the issue with Secretary (Defence Production), who turned it down, ruling that BEL would play the lead role.

While MoD policies slowly evolve towards bringing the private sector into defence, the old co-exists uneasily with the new. Laying down a policy that empowers the private sector on paper is easy; the difficulty lies in actually breaking decades-old patterns of patronising the labs and production units of the Department of Defence Production.

Thursday, 26 April 2007

As dawn broke on the Pokhran field firing ranges late last year, three of India's latest T-90 tanks readied themselves on the firing line. These were the first firing trials to determine whether Indian-manufactured T-90 ammunition could replace the Israeli armoured piercing ammunition that is imported at nearly Rs 10,000/- per round. As the zeroing targets 1800 metres away became visible through the Russian gun sights, the T-90s opened fire. It soon became apparent that the rounds were falling short of the targets, but there was no way to modify the tank's fire control system (FCS) to correct that. Asked to modify the FCS for Indian ammunition, the Russians pointed out that the T-90 contract had no such provision.

An irate Ministry of Defence (MoD) has told Russia that the proposed contract for an additional 347 T-90s depends on Russia modifying their FCS to fire Indian ammunition. And to modify the T-90s that have already been delivered, the MoD is making a potentially revolutionary departure from its traditional policy. It is looking towards India's private sector, and offering to pay most of the development costs for a software solution to the FCS problem.

Relying exclusively on the Defence R&D Organisation (DRDO) for its equipment needs is now in the past for the MoD. Instead, private companies who fulfil certain norms to be eligible for the honorific of Raksha Utpadan Ratna (RuR), will be given specific defence R&D projects and the MoD will pay 80% of the development costs.

Speaking exclusively to the Business Standard, Secretary for Defence Production, Mr KP Singh pointed out that the private sector, which stayed out of defence field due to high costs and uncertainty of military R&D, needed to be harnessed. "There is a need for risk sharing between the government and the private sector. The DRDO works with 100% government money. The private sector, in contrast, is not being given development costs. The Department of Defence Production will now fund the private sector R&D as well."

This significant new announcement is backed with money. A corpus of Rs 100 crores is being introduced, which will be funded from the MoD's capital acquisition budget. In terms of the overall military R&D spend, this is small change; the DRDO budget for this year is Rs 3186 crores. But it is a clear acceptance of the need to reduce the government's exclusive dependency on the DRDO and, like the USA, fund research by private corporations that have established themselves in the defence field.

The MoD has asked the Chief of Integrated Defence Staff (CIDS), Lt Gen HS Lidder, to identify ten important military R&D projects for the private sector, which can be subsidised by the MoD. Mr KP Singh stated, "I've asked the CIDS to keep the projects and the wherewithal ready for when the private sector companies come. I've suggested that he earmark ten projects, which we are ready to fund, the first of them being the T-90 FCS adjustment to fire Indian ammunition.

Blocking the immediate start of private sector R&D is the MoD's failure to identify any private companies as RuRs. A committee headed by Probir Sengupta was set up in May 06 to identify companies who fulfil RuR requirements, which are currently pegged at Rs 1000 crores in annual sales, Rs 100 crores in capital, and a proven track record in military R&D. Names should have come last September, but delays continue.

Private sector defence manufacturers welcome the MoD's proposal, but say that the requirements for RuR status have been pegged too high. Dr AJ Prasad from HBL, a Hyderabad based defence manufacturer, while agreeing on the need for strict requirements, says, "private sector companies who fulfil the MoD financial conditions do not have much of an R&D record. The companies that do serious R&D don't fulfil the Rs 1000 crore requirement. So there's a need to re-evaluate the issue of size and bring it down to perhaps half."

The MoD, nevertheless, is enthused by being able to tap into an increasingly capable private sector. Mr KP Singh declares, "I'm very optimistic. In 15-20 years, there will be an explosion of the private sector in the field of defence. We'll make the best use of them in defence production." But while this signals a dramatic shift in MoD views, resistance is building up from the DRDO, which sees its turf being encroached upon and from the Defence PSUs who fear aggressive competition from private players.

Tuesday, 24 April 2007

Last week, on the sidelines of the Nuclear Suppliers’ Group (NSG) meeting in South Africa, India and the US moved a step closer to civil nuclear cooperation. Regardless of the eventual outcome of that nuclear deal, India’s domestic debate on its pros and cons has surely been one of the most passionately argued. The battle lines have been framed as a strategic choice between joining the global power elite on the one hand and retaining sovereignty over decision-making on the other. Ignored in this debate has been the unsexy dimension of strategic morality, except through the Left’s customary flagellation of Western imperialism. The use of morality as a strategic tool has been ignored altogether.

This is unsurprising in a rising power like India; adolescents often find moral issues inconvenient in exercising their empowerment. Many of India’s new-generation strategic thinkers deride morality as a determinant of foreign policy, arguing that only inconsequential nations can afford the luxury of sitting on the high moral ground. Great Powers, goes their argument, act on an international stage that is fraught with contradiction and so they must inevitably behave hypocritical, paying lip service to principle while acting on practicality. Bismarck, long ago, thundered that the great questions of the time would not be settled by resolutions and majority votes, but by blood and iron.

India, however, has a half-century of experience in the strategic mobilisation of morality. The early Indian foreign policy of non-alignment and rejection of nuclear weaponry, flowing logically from the moral norms of Mahatma Gandhi, had generated for a fledgling India far greater power and influence than its reality commanded. Nehru’s voice, as the leader of a poverty-stricken and militarily weak country, echoed across the globe; it was amplified by moral force. An Indian motion in the UN General Assembly was often endorsed by others simply because it was Indian. While many of Nehru’s policies have been justifiably discredited, his strategic use of morality remains a stunning success.

The use of moral force to leverage a nation’s international position is not a quaint notion from an idealistic era. Contemporary realist strategy recognises it as a usable instrument in a nuclear environment, where the sword can only remain in the scabbard. French strategist Andre Beaufre, one of the most incisive thinkers of the nuclear age, likened the use of psychological tools, such as morality and humanism, to opening a new front on the psychological plane. In India’s propagation of non-violence, and later non-alignment and universal nuclear disarmament, and in the Soviet Union’s use of the moral levers of anti-colonialism and Marxism, Beaufre saw it “possible to take over abstract positions, and…deny them to the other side.”

In the case of a fledgling India, this was an exquisitely tailored strategy: turning its weakness into strength, creating the fetters with which “the Lilliputians tied up Gulliver”. And today a debate over whether India should embrace the United States or negotiate for the same benefits as the nuclear club is a false one. Instead the search for a strategy must centre on how India can sit in the boardroom of World Inc without casting aside the levers that served her so well for half a century.

The question, it must be remembered, is not about idealism, but realism. It is only the very powerful who can afford to cast aside morality. Andre Beaufre postulates three variables in a country’s options: material force, moral force and time. If material force available to a country is overwhelming, moral force will be unnecessary; goals can be achieved in a relatively short time. (It will be argued that Iraq disproves this, but the counter-argument is that the US is only failing because it has failed to apply adequate force.) When material force is small, however, as is still the case with India, moral force must necessarily supplement it and the effects felt only over a period of time. What New Delhi must consider is ways to build closer relationships with the US while retaining India’s traditional ability to marshal moral force.

In the history of every country come moments when it must trim its sails according to the winds and riptides of global changes, and reposition itself favourably in a new strategic framework. In the aftermath of World War II, a weakened and diminished Great Britain, even while shedding its aspirations of global superpower, retained international influence by creating a troika of diplomatic levers: a nuclear deterrent, its NATO membership and its unquestioning special relationship with the United States. Morality did not figure in this calculation, a mistake that has put Britain in Iraq, Afghanistan and in the popular lexicon as the 51st state of the USA.

India is poised today at a defining moment in its history, but as an ascending power, far better positioned to make calibrated and nuanced decisions. It would be a pity if India steps onto the world stage entirely abandoning a remarkable history of Gandhian morality that could provide a unique brand identity to its foreign policy.

Tuesday, 10 April 2007

Samuel Huntington, the American political philosopher famous for his provocative “Clash of Civilizations” thesis, initially shot to fame with his 1957 study of civil-military relations, “The Soldier and the State”. In that seminal work, Huntington concluded that “objective civilian control” over the armed forces keeps the military out of politics, by granting it a sphere of “autonomous military professionalism”. Granting the military control over its own realm, reasoned Huntington, motivates it to excel professionally as well as to stay out of the political space where civilian institutions hold sway.

Since independence, India’s civilian hierarchies have adhered to the Huntingtonian philosophy, stabilizing the country as a stable democracy. Both sides justifiably claim credit. The military, while earning respect for its professionalism, has nurtured an apolitical ethos, even through provocations like the 1975-77 Emergency and the BJP’s attempt to identify itself with the army in its electoral campaign after the 1999 Kargil victory. The civilian institutions, on their part, have provided reasonable political leadership, avoided politicising military promotions and selections, and granted the armed forces functional autonomy within the military sphere.

This unwritten separation is being increasingly tested, most recently by a Delhi High Court order of 19th March 07, which is a potentially troublesome judicial intrusion into the structure of the military hierarchy. Ruling on a writ petition filed by a serving army officer, Brigadier SB Chail, a two-judge bench has directed the army to consider his request for creating a major general’s vacancy for him. The court has ordered the Defence Secretary to personally meet the brigadier to understand his point of view. And, for the first time, the court has guarded against the military’s proclivity to kill such petitions by stonewalling them until the petitioner retires, after which a case against supersession becomes invalid. Aware that Brigadier Chail was retiring on 31st March, the Delhi High Court directed the army to consider Brigadier Chail’s request to continue to remain in uniform beyond 31st March on the “supernumerary strength” of the army.

In this order the courts have crossed a rubicon, intervening decisively on a matter relating directly to personnel management within the armed forces, and the structure of the officer cadre. Furthermore, by effectively placing Brigadier Chail on the army’s supernumerary strength, the courts have added teeth to their award. The mechanism of “supernumerary strength” allows an officer to continue in service beyond his retirement date by creating a special vacancy for him, over and above the vacancies already sanctioned by the government for the armed forces.

It is hard to believe that the Delhi High Court has jolted a finely balanced civil-military relationship without serious thought. The fact is that Brigadier Chail’s petition had merit that was difficult to overlook. As the Principal Records Officer of the Indian Army, he headed an independent organisation of over 500 officers, who ran 51 Records Offices that handled the policies and records related to the postings, promotions, pensions and salary entitlements of over 13 lakh soldiers. The Records Offices handle as much responsibility, a greater workload, and have far more officers than several other army departments headed by major generals (such as the Corps of Military Police, the Army Education Corps and, ironically, the Judge Advocate General’s Branch). The courts concluded that there was a prima facie case for the Records Offices to be headed by a major general. As the senior-most serving officer in the Records Office, Brigadier Chail would be entitled to that promotion.

The Delhi High Court faced a Hobson’s choice between respecting, on the one hand, the traditional hands-off policy towards military hierarchies and, on the other, issuing a decision because it believes the present structure is patently unjust. Putting off a decision, the court lobbed the ball back into the MoD’s court, giving it the opportunity to solve the issue internally. But MoD inflexibility has not helped. Having heard Brigadier Chail, as directed by the court, the Defence Secretary has decided that the MoD will continue to oppose his promotion before the Delhi High Court. The court, therefore, might be left with no option but to direct a change in the army’s internal hierarchy, an interventionist judgement by Huntington’s standards.

None of this is necessary. The Delhi High Court is deciding this case only because of parliament’s delay in passing the Armed Forces Tribunal Act, which was placed before it in 2005, for setting up a specialised quasi-military higher court to review cases relating to the military. The Armed Forces Tribunal Bill, 2005, will create an appellate mechanism, manned by retired heads of the MoD’s Judge Advocate General’s Branch and retired judges from the higher judiciary. This body will take over the 8500 military cases pending before the higher judiciary, allowing judges sensitised to military matters to rule on sensitive issues like court martial reviews, promotions, supersession and the military hierarchy. And since the Armed Forces Tribunals will be viewed within the armed forces as much military judicial bodies, civil-military separation will be reinforced.

For now, though, the Armed Forces Tribunal remain just a proposal. Parliament’s Standing Committee on Defence has sent the draft bill back to the MoD for clarifications and review. While the debate over “judicial activism” and “judicial intervention” raises dust and hackles, a mechanism to create an efficient and non-confrontationist judicial alternative gathers dust.

India will be required to absorb approximately Rs 90,000 crores worth of offset projects that will flow from its projected military purchases of $100 billion (Rs 4,30,000 crores) over the next five years. Every foreign contract worth Rs 300 crore or more will require the vendor to plough back 30% of the contract value in offsets, or production in India that is directly related to that contract.

State-of-the-art is the new mantra in offset partnerships. For the first time last Tuesday, the Ministry of Defence (MoD) publicly announced its demand for cutting edge technology transfers under the Defence Offset Policy. The head of MoD’s Defence Offset Procurement Agency (DOFA), Dr Kiran Chadha, minced no words in telling executives from European defence giant, EADS, that New Delhi is displeased by the tendency to palm off outdated technology. Dr Chadha complained that “when foreign companies and vendors choose to share their technology with us, they do not --- and I repeat they do not --- share with us their core technologies. And therefore we are a little unhappy.”

This reluctance to transfer core technologies --- in highly restricted fields like missile guidance, electronic warfare and night vision image intensification --- is sought to be whittled away by permitting technology transfers as offsets in defence deals. The monetary value of the technology, being highly subjective, will be hammered out in a negotiating committee. But the MoD has signalled that it will no longer accept the earlier practice of handing over a blueprint in the garb of technology transfer. Instead of simple blueprint-based manufacture, vendors would have to part with technical documents relating to materials and design.

Such is the need for high technology, Business Standard has learned, that the MoD has waived the offset requirement in at least one ongoing purchase, where the technology considered vital for Indian defence. The MoD has refused to confirm or deny this, or to identify the product. Offsets have also been waived for procurements under the MoD’s “fast track procedure”.

With high technology the new buzzword, India’s information technology industry is being brought into offsets. Minister of State for Defence, Rao Inderjit Singh has directed the MoD to organise a half-day seminar in May with IT majors like TCS, Infosys and Wipro, to garner industry views on structuring IT-based offsets. The industry has welcomed the initiative. NASSCOM chief, Kiran Karnik told Business Standard, “Foreign vendors have traditionally concluded offset deals in the manufacturing or trading sectors, so they have viewed offsets as an inconvenience, a cost in finalizing a deal. With offsets in IT, vendors could see it as a gain for themselves”.

The drawback, for IT companies, lies in the conditionality laid down by the MoD for entering the defence field; getting the required industrial licence is often a lengthy and frustrating process. The NASSCOM chief also points out that, unlike in the manufacturing sector where companies are required to have a certain size, capability and turnover, IT companies should be permitted to participate in offsets regardless of size, the only proviso being their ability to absorb offsets. This has been accepted by the MoD, which has now announced that IT companies of all sizes could tie up offset partnerships. DOFA chief Dr Kiran Chadha promises, “This will be clarified to the IT industry by the MoS for Defence Production, Rao Inderjit Singh, during the industry seminar next month.”

Unlike conventional industry bodies like CII and FICCI, the IT industry body, NASSCOM, has not yet set up a defence cell. Individual companies are driving their respective initiatives into the sector of defence design and offsets.

Monday, 9 April 2007

Until the Defence Offset Policy was framed in 2005, India --- the developing world’s biggest arms buyer --- had never demanded offsets, even as smaller buyers like Malaysia, Korea and South Africa drew billions of dollars worth of foreign investment as conditions for the weaponry they bought. But now, India is not just richer, it’s also savvier. New Delhi’s $100 billion budget for weaponry means that foreign suppliers must tie up with Indian companies offset agreements worth $21 billion (Rs 90,300 crores) by 2012.

Foreign vendors, unsurprisingly, are unhappy with the idea that 30% of every arms deal worth over Rs 300 crores must generate business in India’s economy. Offsets, the US government officially declares, are undesirable, since they increase the cost of a deal. But with little choice but to accept offsets, foreign suppliers, particularly from the USA, have been trying to shape India’s offset policy to their advantage.

The US-India Business Council (USIBC), representing 250 of the biggest US companies investing in India, presented India’s Defence Secretary Shekhar Dutt with a document listing “International Best Practices” in defence offsets, suggesting India study this before finalising its offset policy. On Tuesday, Dr Kiran Chadha of the Defence Offset Facilitation Agency (DOFA), the MoD’s nodal agency for planning and implementing offsets, officially responded, informing an audience of European and Indian defence manufacturers that MoD experts were competent to formulate policy, having “deliberated on the global practices on offsets, and studied the offsets programmes of companies across the world to arrive at the policy as it exists today.”

The DOFA chief announced a slew of new decisions on offsets, responding point-by-point to suggestions made over the last year by foreign vendors.

• The MoD has accepted the suggestion that India should permit “offset banking”. This allows vendors to set up projects in partnership with an Indian company and then credit the value of business generated as offsets for a future defence contract. The USIBC has argued that this provides offset partnerships with a long-term, rather than a single-contract perspective. Take for example, a joint venture, set up as an offset obligation in a F-16 contract, to manufacture F-16 fighter radios. If offset banking was allowed, the JV could continue producing radio sets as part of the F-16 global supply chain, even after the Indian contract was concluded.

• The MoD rejected the suggestion to allow “indirect offsets”, such as joint ventures in key economic sectors like energy, infrastructure, water and high-technology. The USIBC, amongst others, argued that JVs in non-defence sectors like thermal power should be given offset credits for unrelated defence contracts, e.g. for supplying night vision equipment.

• The MoD also rejected the suggestion to allot “credit multipliers” to offset proposals. Foreign vendors suggest that India could draw offsets into sectors that are higher national priorities by allotting projects in those areas higher credit multiplier ratings. E.g. by allocating a credit multiplier of 4 to a key software development project, a $50 million investment in that project would bring a vendor offset credits of $200 million. The USIBC points out that some countries use multipliers of up to 30 to encourage high technology offset investment.

• The MoD announced that it would amend its Defence Offset Policy to dispense with offsets in procurements that are processed under its fast track procedure. The logic is that tying up offsets cannot delay urgently needed items, and the waiver from offsets will provide a motivation for quick delivery. The DOFA chief says, “After the order is issued the product will have to be supplied in 12 months flat. Of course there will be a penalty clause for no compliance”.

The DOFA’s nimbleness is not confined just to flexible and transparent decision-making. The DOFA chief assured private industry that the Defence Offset Policy would evolve continually and quickly. Instead of going to the Cabinet for a brand new policy each time changes were required, Kiran Chadha explained, “We just have to take approval from the Defence Procurement Board and from there, with their recommendations and their views, it’ll go to the Raksha Mantri… and the amendments will be effective.”

For the first time, India’s Ministry of Defence (MoD) has publicly put a figure on its forthcoming defence purchases. On Tuesday, Dr Kiran Chadha, head of the MoD’s Defence Offsets Facilitation Agency (DOFA) told a gathering of Indian and European defence industry that India will buy $100 billion worth of military equipment over the next five years. At current exchange rates, that amounts to Rs 4,30,000 crores over the 11th defence plan period from 2007-2012.

The audience, executives from European Aeronautic Defence and Space Company (EADS), had gathered to discuss potential offset partnerships with Indian entrepreneurs invited by the Confederation of Indian Industry (CII). Their mental cash-registers could easily process the MoD figures: every foreign defence contract worth Rs 300 crores or more requires the foreign vendor to plough back 30% of the contract value as offsets, which are co-production or purchase agreements with Indian defence producers. If a conservative 70% of India’s $100 billion is spent on foreign equipment, Indian businessmen would benefit from offset opportunities worth $21 billion (Rs 90,300 crores).

As startling as the amounts involved were the MoD’s far-reaching changes and clarifications to the Defence Offsets Policy that was first formulated last September as a part of India’s Defence Procurement Plan – 2006 (DPP–2006). On Tuesday, divulging for the first time that India’s Ministry of Commerce was formulating a National Offset Policy, Kiran Chadha explained that the Defence Offset Policy would continue to operate independently, since “we cannot equate rice and wheat with arms and ammunition.” It remains unclear whether the Ministry of Civil Aviation (MoCA), which has its own offset policy for aircraft and equipment purchased from overseas, will operate under the new National Offset Policy.

It was also announced that the MoD had accepted a major demand from India’s growing private defence sector. In bidding for offset partnerships with foreign arms vendors, India’s private defence manufacturers will henceforth be treated on par with the eight Defence Public Sector Undertakings (DPSUs) like Bharat Electronics Limited (BEL) and Hindustan Aeronautics Limited (HAL), which have traditionally obtained preferential treatment. Now foreign vendors can choose Indian private companies as partners for implementing offset obligations.

Kiran Chadha stated that, “For the majority of projects that are ready for procurement and the 30% offset obligation, it will be the foreign companies that will choose their Indian partner, and they can choose more than one Indian private partner.”

This is already happening. India has just finalised it first offset agreement, worth $15 million (Rs 60 crores), with Israeli company ELTA, in a deal to supply India Medium Power Radars. ELTA’s offset partners will be private companies, L&T and Astra Microwave from Hyderabad. The offset proposals for the purchase of the navy’s newest fleet tanker involve 8-10 Indian companies. And in a major statements that DPSUs would now compete on level terms with the private sector, the MoD has ordered the redrafting of two tender proposals, which had mandated BEL and HAL as offset partners. In those proposals for buying helicopters, the vendors can choose any Indian companies as offset partners.

The MoD is also guarding against any tendency amongst foreign vendors to avoid offset obligations; it has mandated that every offset agreement will have to be coterminous with the main contract and directly related to it. For example, in a transfer of technology (ToT) deal for manufacturing helicopters in India, the offset deal must involve parts or technology related to that very helicopter and must be completed by the time the last payment is made to the foreign vendor. In this, the MoD has drawn on earlier experiences, where foreign vendors tended to avoid offset obligations. Says Kiran Chadha, “Some of the offsets programmes which were finalised by HAL almost 15 years ago have still not been implemented… We do not want to run after every vendor after the contract is over.”

Representing an increasingly confident private sector, active Defence Cells within industry bodies like the CII are pushing the MoD for a greater role in defence. The MoD, realizing that its eight DPSUs and 40 Ordnance Factories cannot deliver alone, is clearing the decks for the private sector to build up defence capabilities through offset opportunities.

Tuesday, 3 April 2007

On the 1st of April, the Ministry of Defence will start spending Rs 41,922 crores, allocated in the defence budget for capital acquisitions, or the purchase of arms, equipment and vehicles above a certain value. Compared to Rs 37,458 crores allocated under the capital head last year, this year’s hike of Rs 4,464 crores apparently raises the capital budget by 12%, just enough to match inflation on defence equipment. But, since the MoD will surrender over Rs 3,000 crores of unspent money on 31st March 07, the actual increase over last year’s revised estimates is a sizeable 22%.

Defence Minister AK Antony has indicated that last year’s surrender of funds was an aberration, declaring that India’s defence modernisation was 15 years behind schedule and that “we will make sure that not a single rupee is left unspent” from the budget this year. An understanding of how the capital budget is spent is necessary for grasping the implications of Mr Antony fulfilling his promise.

The most striking thing about capital expenditure is that most of it is pre-committed. Like in a household that has financed the purchase of too many goods, 75% of India’s annual capital allocation goes on instalments for contracts entered into in previous years. Half the capital budget, some Rs 21,000 crores, will go to Indian suppliers: the 39 ordnance factories, the 8 defence PSUs and, to a lesser extent, to private Indian companies, for equipment like the thousands of heavy trucks that the army buys each year. That will leave about Rs 21,000 crore ($5 billion) in the capital account for foreign arms corporations this year.

Some 80% of this amount too is pre-committed. Since major defence purchases are paid for over 7-10 years, India will pay instalments this year for earlier purchases like Sukhoi fighters, the Gorshkov aircraft carrier, T-90 tanks, Talwar class frigates, Scorpene submarines, the Phalcon Airborne Early Warning System and for dozens of smaller contracts that add up to enormous sums. After these instalments are paid, a modest Rs 3600-4500 crores ($1 billion) will be available for new contracts this year.

But foreign arms vendors will still flock to Delhi. These one billion dollars are merely the 25% down payment on new deals. In other words, with $1 billion in hand, the MoD can actually sign contracts this year for four times that amount, or about $4 billion, with the balance amount paid over following years. And like this year, future defence allocations will have no choice but to fork out the annual instalments.

Noteworthy is the total absence of legislative control over allocating and spending the capital budget. Each year, the legislature unquestioningly allocates the amount committed in previous years’ arms contracts, with a hefty amount added for signing new contracts. Partly due to its own ineptitude in matters of defence, Parliament asks no questions and the government gives no explanations. Unlike other democracies where the legislature scrutinises each contract for their financial effect on future defence spending, in India all this is the exclusive preserve of the executive --- the military, the MoD, the Finance Ministry bureaucracy, and the cabinet. The only check on the MoD in India is the Finance Ministry. The latter, aware that the expanding dynamic of arms deals will force it to allocate funds in future years, tracks the future budgetary implications of deals signed each year.

In a couple of months, the same MoD that returned over Rs 3000 crore on 31st March, will be asking for additional capital allocations this year for defence modernisation. Their argument: the allocations already made will be largely consumed by previous years’ contracts. The MoD made exactly this argument in 2003-04 in a secret letter to the MoF that has been reviewed by the Business Standard. Allocated Rs 18,050 crores for fresh capital expenditure that year, then Defence Secretary Subir Dutta demanded from the MoF an additional Rs 8679 crores. His calculations (see table) were impeccable: committed liabilities, or instalments on previous years’ arms purchases, were Rs 16,843 crores. That left just 1,206 crores for new contracts in 2003-04. Mr Dutta tabulated the contracts that had already been negotiated with arms companies. His demand for an extra Rs 8,679 crores for the current year’s outgo involved paying over Rs 40,000 crores in the following years. It was taken for granted that parliament would unquestioningly sanction that amount.

Finance Minister P. Chidambaram assured parliament that whatever is needed by the defence services would be made available. While that was a political rather than an economic statement, the MoD’s additional demands will soon be on his desk. The effects of these could continue to be felt over the next decade.